Is the following, revenue expenditure or capital expenditure in the context of government budget? Give reason.
(i) Expenditure on collection of taxes.
(ii) Expenditure on purchasing computers.
An expenditure that neither creates an asset nor reduces a liability is categorised as revenue expenditure. If it creates an asset or reduces a liability, it is categorised as capital expenditure.
1. Expenditure on collection of taxes is a revenue expenditure. This type of expenditure includes the government expenditure which does not cause any reduction in government liabilities and also does not create assets for the government.
2. Expenditure on purchasing computers is a capital expenditure. This expenditure includes that government expenditure, which causes reduction in the government liabilities as well as creates assets for the government.
Define externalities. Give an example of negative externality. What is its impact on welfare?
An externality is said to occur when the actions of one entity bears an impact on other entities. These externalities can be positive as well as negative. Negative externalities occur when the consumption or production of a good causes a harmful effect to a third party. It is an action of one person adversely affecting the others.
Examples of negative externalities:
1) If you play loud music at night your neighbour may not be able to sleep.
2) If you produce chemicals and cause pollution, then as a side effect, local fishermen will not be able to catch fish. This loss of income will be the negative externality. The hazardous chemicals in water bodies and the surroundings adversely affect the health of the people. Also, it contributes to the environmental degradation along with increasing the pollution levels in the country.
Thus, by endangering and affecting the life of the people living in the surrounding areas, it reduces the overall welfare of the society and creates negative externality.
Recently Government of India has doubled the import duty on gold. What impact is it likely to have on foreign exchange rate and how?
With a rise in the import duty of gold, the cost of gold increases and thereby the import of gold will fall. This reduces the demand for foreign currency. With the supply of foreign currency remaining same, the foreign exchange rate would fall. This implies appreciation of rupees. This can be explained with the help of the following diagram.
In the diagram, DD and SS are the initial demand curve and supply curve for foreign currency respectively. E is the initial equilibrium point, with OR as the equilibrium exchange rate. A fall in the demand for foreign currencies (due to a fall in imports) shifts the demand curve from DD to D' D'. With the shift in demand curve, new equilibrium is established at point E, where the exchange rate falls from OR to OR1. A fall in the exchange rate implies currency appreciation.
Define money supply and explain its components.
By money supply we mean the total stock of monetary media of exchange available to a society for use in connection with the economic activity of the country. Supply of money refers to the total stock of money (in the form of currency notes and coins) held by the people of an economy at a particular point of time. The following are the components of money.
(i) Currency Component: It includes,
a) Currency notes in circulation issued by the Reserve Bank of India.
b) The number of rupee notes and coins in circulation.
c) Small coins in circulation.
(ii) Deposit Component: The other important components of money supply are demand deposits of the public with the banks. These demand deposits held by the public are also called bank money or deposit money. Deposits with the banks are broadly divided into two types: demand deposits and time deposits.
Demand deposits in the banks are those deposits which can be withdrawn by drawing cheques on them. Through cheques, these deposits can be transferred to others for making payments from which goods and services have been purchased. Whereas time deposit is a deposit in a bank account that cannot be withdrawn before a set date or for which notice of withdrawal is required.
Give meaning of balance of trade.
Balance of Trade is simply the difference between the value of exports and value of imports. It denotes the differences of imports and exports of a merchandise of a country during the course of year. Balance of Trade (BOT) for a country refers to the record of visible trade transactions of the country with the rest of the world.
Explain the meaning of balance of payments deficit.
The deficit in the BOP is governed by the balance of autonomous transactions in the BOP. The BOP would show a deficit if the autonomous receipts are lesser than the autonomous payments. As autonomous receipts implies a receipt of foreign exchange and autonomous payments implies a payment of foreign exchange, so, it can be said that BOP would show a deficit if the foreign exchange receipts are less than foreign exchange payments. In other words, the BOP deficit would be reflected in a depletion of foreign exchange reserves of the country.
Define marginal propensity to consume.
Marginal Propensity to Consume is the proportion of additional income that an individual consumes. MPC refers to the ratio of change in the consumption expenditure and change in the disposable income.
Explain the significance of 'store of value' function of money.
A store of value is the function of an asset that can be saved, retrieved and exchanged at a later time, and be predictably useful when retrieved. It is an important function of money. This implies that wealth in the form of money can be stored easily as a medium of exchange for future use. For example, money can be stored in banks for meeting emergency and future needs. The importance of the money as store of value is explained in the following points.
1) Money is not perishable and its storage costs are also considerably lower.
2) It is also acceptable to anyone at any point of time.
3) Wealth can be stored in the form of money for future use.
4) In the barter system, it was very difficult to store goods, especially perishable goods for the purpose of value storage. This limitation of barter system is overcome by the money due to its potential to store value.
5) The contractual or future payments were very difficult to be made in barter system. Money helps people to demand and forward loans and to make future and deferred payments along with interests.
Define government budget.
A government budget is a government document presenting the government's proposed revenues and spending for a financial year. It is a financial statement showing item-wise expected government receipts and government payments during a particular financial year. It also presents the government's report on the financial performance during the previous fiscal year.
Explain the significance of 'medium of exchange' function of money.
Money, as a medium of exchange, means that it can be used to make payments for all transactions of goods and services. It is the most essential function of money. Money has the quality of general acceptability so, all exchanges take place in terms of money. In other words, money eliminates the need for double coincidence of wants for an exchange to take place and can be performed independently of each other. Moreover, money has widened the domain and scope of market. Significance of ‘medium of exchange’ function of money are:
1. This function has removed the major difficulty of lack of double coincidence of wants and inconveniences associated with the barter system.
2. Use of money allows purchase and sale to be conducted independently of one another.
3. This function of money facilitates trade and helps in conducting transactions in an economy.
4. Money has no power to satisfy human wants, but it commands power to purchase those things, which have utility to satisfy human wants.